The Original Ponzi Scheme

From across the Atlantic Ocean, North America beckoned to millions of Italians. They were unemployed and poor, but they knew they could find work, perhaps well-paying work, in the United States They gave up everything to buy a ticket for the voyage across the Atlantic and the chance at a new life. With this chance of success, however, came the risk of loneliness and failure. Many immigrants would return to Italy as poor and as desperate as they were when they had left.

Carlo Ponzi Arrives

Carlo Ponzi decided to accept that challenge. He arrived in the United States in November, 1903. Hardworking and confident, Ponzi was sure that he would make a fortune. Soon he was working for relatives in the wholesale food business. The hours were long and the pay was low, but for the first time in his life, Ponzi was able to support himself.

Seeking every advantage in his adopted country, Ponzi quickly learned how to write and speak English. But he also learned that selling food was a tough way to make one's fortune. Within a year, the family business went bankrupt, and Ponzi was out of work.

Perhaps success didn't come so easily in the United States after all. Drifting north to Canada, Ponzi settled in Montreal, a French-speaking city in the province of Quebec. With his sharp cloths and confident manner, Ponzi soon found employment there - and the opportunity he needed.

The Immigrant's Banker

Ponzi joined the staff of the Banco Zarossi, which held the savings of thousands of Montreal's Italian immigrants. Zarossi paid the same low rate of interest - about two percent - as the other Montreal banks. But the bank's customers trusted Louis Zarossi, the bank president, perhaps because he was Italian like them.

Ponzi became friends with Zarossi but soon discovered that his employer was in serious trouble. Zarossi had been making risky investments with the bank's money, and the cash in the vaults was quickly disappearing. To avoid a crash of the bank - and a jail sentence - Zarossi desperately needed an investor to put more cash into the bank.

After a few weeks, Ponzi joined up with Angelo Salvati, an old friend. Together, the two men hatched a complicated plan to take over the Banco Zarossi. Salvati, who was as poor as Ponzi, played the part of a wealthy investor who was ready to put $50,000 into the bank. At the same time, Ponzi and Salvati convinced Zarossi to offer ten percent interest, instead of two percent, to his customers. The increase would result in a rush of new deposits as the customers looked for a better return on their money.

According to the plan, before he had to pay out the interest, Zarossi would flee the city. When the depositors began demanding their interest payments, Zarossi would declare bankruptcy, and his bank's debts would be cancelled. Salvati would then make his $50,000 investment into the failed bank.

There was one part of the plan, however, that Zarossi didn't know about. After he was safely out of town, Ponzi and Salvati intended to take over his bank.

The Collapse of Banco Zarossi

Expecting to return to his bank, Zarossi agreed to the plan. At first, everything went smoothly. Depositors lined up for their new accounts, Zarossi left Montreal, and the Banco Zarossi quickly closed. To complete their plan, Ponzi prepared to visit the Banco Zarossi's branch offices, where he would demand the transfer of cash to the central bank. In order to succeed, Ponzi had to look the part of a bank officer. He paid for his new clothes, his hotel rooms, and his train tickets by forging a check from one of the bank's customers.

The scheme could have worked if Ponzi had not made a crucial mistake: He had trusted Angelo Salvati. Seeking to take over the bank by himself, Salvati reported Ponzi to the police. With plenty of cash, blank checks, and other evidence scattered around his room, Ponzi didn't have a chance of successfully defending himself. A Canadian court convicted him of forgery and sentenced him to three years of hard labor.

Ponzi's jail term gave him plenty of time to think about his future. On his release, Ponzi decided to become his own boss and drifted around the southern United States, inventing new moneymaking schemes as he went. But few of them succeeded, and none of them made much money, so Ponzi eventually went back north and settled in Boston, Massachusetts.

Opportunities in Boston

Boston was filled with poor, struggling Italian immigrants who were working hard to save money and built their futures. After paying their families' expenses, they would deposit their few remaining dollars into Boston's savings banks, where money earned four or five percent interest in a year. This was a slow way to earn money, and many immigrants resented the big banks and the wealthy Boston businessmen who owned them.

Ponzi felt there must be a better and faster way to make money in this land of opportunity. Otherwise, why not go back to Italy, where even a poor person could enjoy the warm weather and good wine? Perhaps Carlo - now known as Charles - Ponzi could show these immigrants the way.

Ponzi came up with another plan. He would accept money from investors and double it in just three months. Instead of the low interest paid by the big, established banks, Ponzi would offer his customers 400 percent a year.

How could he possibly do this? To anyone who would listen, Ponzi explained that by luck and opportunity he had stumbled upon a simply way to make a lot of money In fact, his plan was as easy as going to the post office to mail a letter.

Ponzi had learned that post offices around the world sold coupons that people could exchange for stamps. Thus someone writing a letter to a foreign country could pay for the stamps needed for a reply.

Of course, Ponzi's scheme had a catch, which depended on the high inflation that was lowering the value of European currencies. Ponzi claimed he could buy reply coupons in Europe and then redeem them for a higher price back in the United States. With the extra money he received, Ponzi could buy even more coupons in foreign countries that could be exchanged for even more money in the United States.

Trusting Customers

The scheme was complicated, especially when Ponzi explained it in his rapid, confident, and cheerful voice. Yet he had little trouble lining up his first customers in 1919. To anyone who would listen - factory workers, ditchdiggers, office clerks, waiters, and schoolteachers - he confidently guaranteed a return of 50 percent in 45 days and 100 percent in 90 days. Within weeks, money began to arrive in the cramped, one-room office Ponzi had rented in downtown Boston.

His new business, the Securities Exchange Company (SEC), accepted any amount from $10 to $10,000. The company issued three differently colored slips of paper to investors. Green notes were for investments of $100 or less. Up to $1,000 bought an orange note, and blue notes were for those risking more than $1,000. In three months, as their notes came due, each of Ponzi's investors received an official-looking notice in the mail. The notice invited them to come to the SEC office to collect their money and, if they wished, to make a new investment.

As his company grew, Ponzi developed a network of sales agents. He offered them a ten-percent commission, meaning they could keep a dime of every dollar invested. Working in factories, shops, and restaurants, Ponzi's agents sold his colored notes to their friends, relatives, and co-workers.

By the end of February 1920, the SEC had brought in more than $5,000. New investors were signing up every day, and by March Ponzi was holding more than $30,000. Although his debts stood at $45,000, Ponzi was not worried. His investors were happy, and rather than turning in their notes for cash, nearly all of them reinvested their money in new notes. The clerks Ponzi had hired for the SEC office rarely had to pay out any money.

A Life of Ease

Believing he had finally found the road to easy riches, Ponzi began living as well as the wealthiest families in Boston. He bought fancy cars, expensive suits, and a mansion with five acres of lawn. His mother arrived from Italy to live with her famous and successful son.

The young tycoon kept busy depositing his money in two dozen banks throughout New England. Charles Ponzi knew better than to bother with postal coupons! No post office held more than a few hundred at a time, and not enough postal reply coupons existed in the entire world to finance his scheme. When an investor turned in a colored SEC note for cash, Ponzi paid off the notes with the money coming from new investos. He put the rest of the money into real estate, small companies, and banks.

Meanwhile, the debt at the SEC kept growing. Ponzi would have to pay his customers eventually - with money he didn't yet have. By the late spring of 1920, as his company's debt ran into the hundreds of thousands of dollars, Ponzi hatched an even better plan. He would close down the SEC and transfer its debts to a legitimate business. He would sell shares of stock in his new business and would balance his books with the money from the stock sale.

Ponzi had been making large deposits in the Hanover Trust Company, a prominent Boston bank. During a meeting with the bank's president, Ponzi demanded that the bank allow him to buy a large share of its stock. When the president and directors refused, Ponzi asked that they close all of his accounts and return his money to him immediately - in cash.

Ponzi knew the Hanover Trust was too small to carry that much cash in its vault. To avoid cleaning out their vaults and creating a panic among the depositors, the bank directors agreed to Ponzi's demand: They would sell him a majority of the Hanover Trust shares. The Hanover Trust Company was now under Charles Ponzi's direction.

Ponzi Goes Legit

Ponzi finally had control of a legitimate business and a chance to transfer the debts of the SEC to the Hanover Trust. Of course, he would not need to meet his debts anytime soon because money was still pouring into the offices of the SEC. A few bankers were openly doubtful of Ponzi's methods, but no one listened to them. After all, thousands of people were making money. It seemed that the entire city of Boston would soon be on Easy Street, thanks to Charles Ponzi and the SEC.

The spreading fame of Ponzi's Securities Exchange Company, however, was causing problems. Some people were forging the colored notes instead of buying them and turning them in for cash. Many investors were writing bad checks, and Ponzi's own salespeople were claiming phony sales in order to collect higher commissions. A competitor opened up across the hall from Ponzi's downtown office and began stealing the SEC's customers with identical claims. Like Ponzi, this company promised to double anyone's money in just three months.

Yet Ponzi honred all his debts, whether they were phone or not. He knew that many people were growing skeptical of his claims and that any failure of the SEC to meet its obligations might start a panic. With his debts growing rapidly, a sudden rush by investors to redeem their coupons would ruin him.

By July 1920, the company had taken in more than $3 million in cash, but it owed more than $4 million to its investors. Ponzi was using newly invested money to pay off the notes as they came due, but how long could he keep that up? Moreover, he was having trouble transferring his obligations to the Hanover Trust or to any other legitimate business. As the summer wore on, he grew desperate to escape the growing mountain of debt.

Drawing Notices

When a furniture dealer sued Ponzi for $1 million, the SEC began to draw notice in the Boston newspapers. Now many Boston bankers and businessmen openly doubted Ponzi's claims. The bad press caused a panic at the SEC's offices. But the run on the business soon ended when Ponzi successfully met the investors' demands.

With confidence restored, a new avalanche of money descended on the SEC. In downtown Boston, a huge line of investors formed every morning in front of Ponzi's office. The line slowly worked its way upstairs and into the main office, where thousands of investors turned over their life savings to the overworked tellers. The SEC was taking in nearly a million dollars a day.

Soon the growing size of Ponzi's operation drew the interest of the United States government. The Internal Revenue Service wanted to look at Ponzi's accounts. Troubled by rumors about the SEC, the attorney general of Massachusetts also started an investigation. Under pressure, Ponzi agreed to let the state examine his books. As a condition of the audit, the attorney general banned the SEC from accepting any more investments. Ponzi could take in no more money; he could only pay it out.

Collapse of the Ponzi Empire

In the heat of the Boston summer, as the investigations and newspaper stories continued, Ponzi's financial empire began to collapse. A series of articles by Clarence Barron, a prestigious financial news editor, cast a harsh light on Ponzi's operation. Barron revealed that Ponzi was investing nearly all his cash in ordinary savings banks, which paid a mere 5 percent interest. Obviously, Ponzi could not possibly keep paying out 400 percent yearly interest when he was earning only 5 percent from the banks. The scheme was bound to fail. Barron accused Ponzi of taking advantage of local immigrants, who had little understanding of financial affairs and who distrusted banks.

Ponzi responded to Barron's newspaper stories by filing a $5 million lawsuit. But Barron and other Boston writers had already done serious damage to Ponzi's reputation. Several banks closed Ponzi's accounts, and frightened investors were redeeming their notes at the SEC. The panic grew worse after a U.S. postmaster announced that neither Ponzi nor anyone else had made large purchases of international reply coupons.

A natural optimist, Ponzi was sure that no mere investigation was going to stop him. He had enjoyed a spectacular rise, and he would stay in business. He still had control of the Hanover Trust. At this time, Ponzi came up with perhaps his most fantastic plan. He would use the bank's assets to buy a fleet of merchant ships from the U.S. government. He would then set up his own merchant marine company and sell stock in the company to private investors. With the money paid for stock in the shipping line, he would settle the debts of the SEC, which he would quickly close down.

When they heard Ponzi's idea, the bank's directors could only look at him in disbelief. With the SEC under investigation and no new money coming into the company's accounts, Ponzi had only his name to raise the cash that was needed for his plan. When the directors refused to put their bank at risk, Ponzi realized his plan would never work.

Angry Investors

Although he confidently denied Barron's newspaper articles, Ponzi was faced with angry mobs in front of his office. Many of them had read a sensational story in the Boston Globe that revealed Ponzi's arrest for forgery in Montreal years ago. The story came complete with Ponzi's mug shots, taken by his Canadian jailers. Suddenly, Ponz's investors wanted their money back - immediately.

When the attorney general completed his investigation of the SEC, he found that Ponzi owed his investors a total of $7 million. However, he had several million dollars less than that in available cash. He was bankrupt - and under arrest.

The attorney general closed down the SEC and the Hanover Trust and forced the SEC to stop making payments to its investors. The State of Massachusetts stepped in to take over the bank, but it was too late. Hanover Trust stockholders were wiped out, and the bank's depositors lost their savings. Several other New England banks holding Ponzi's accounts also failed and had to close down permanently.

Ponzi's dreams of riches and a life of ease came to a swift end when the U.S. government put him on trial for fraud. Ponzi was found guilty and sentenced to five years in prison. After his release in 1924, the States of Massachusetts tried Ponzi and sentenced him to another long jail term.

New Ponzi Schemes

Ponzi lost his house, his business, and his reputation. Despite his spectacular failure, however, he never stopped scheming. After his release in 1934, Ponzi announced that he would soon write his autobiography. To raise money for publishing the book, he offered shares in the book to investors, whom he guaranteed a 100 percent return on their money. Few people took Ponzi up on his offer, however, and the book was never published. That year, Ponzi was deported to Italy and went to work in the financial department of Italian dictator Benito Mussolini - where he secretly stole funds.

As World War II broke out, Ponzi moved to Rio de Janeiro, Brazil, where he worked as a representative for an Italian air company. But when the Brazilian police discovered that the airline was being used to smuggle goods into Italy, they closed down its Brazil office, and POnzi lost his job. Broke and in poor health, Ponzi spent his last months in a charity ward of a Rio hospital, where he died in January 1949.

Ponzi's legacy was a new kind of financial crime: the Ponzi scheme. Through the years, hustlers have tried many variations of the Ponzi scheme - often referred to as a "pyramid game." The scams depend on an ever-larger stream of money from a growing number of trusting investors. New money is used to pay off earlier investors, at high rates of interest. Eventually the money runs out, and the originator of the scheme disappears. Investors who don't collect their profits are left with only worthless promises. Although Charles Ponzi died sick and poor, his name survives whenever swindlers are making money too quickly and at the expense of their unsuspecting clients.